Although 501(c)(3) nonprofit organizations are exempt from the Federal Unemployment Tax Act (FUTA), nonprofits are not exempt from paying unemployment claims at the state level. State Unemployment Insurance (SUI) is an employer-funded tax program that provides short-term benefits to employees who have lost or left their job. Nonprofit organizations are not automatically exempt from SUI, but they do have a choice for how to pay for unemployment claims. Nonprofit organizations may participate in their state’s SUI tax program, or they may choose to become a reimbursing employer instead.
SUI is employer-funded, which means that the tax is not withheld from employee’s wages. Taxes differ from state to state. The tax rate is a percentage of an employee’s wages, and the state sets a percentage range for your organization to pay based on your payroll and claim history. This tax rate is, of course, just an estimate. Some nonprofits may end up paying more in unemployment taxes than what the state actually pays out to the organization’s former employees. This can make SUI a disproportionate financial burden for some organizations.
The Federal Unemployment Tax Act of 1972 allows nonprofits to opt out SUI taxes if they choose. Instead, the organization reimburses the state only for direct unemployment claims paid to former employees. The organization pays the actual dollar amount of each claim, rather than pre-paying an estimated percentage with SUI. When deciding whether or not to opt out of SUI, it’s important to consider the scale of the organization, past payroll claims, funding, and budget.
Large organizations with stable employment may save money by option out of SUI and becoming a reimbursing employer instead. But for small nonprofits with fewer than ten employees or organizations that experience regular layoffs, it’s safer to pay regular unemployment taxes. To help make your decision, you’ll need to look back at prior year SUI rates and compare that to unemployment claims. You’ll also want to consider the stability of your funding and your ability to budget for unexpected claims. A sudden decline in funding could result in layoffs – followed by a large tax bill for unemployment claims if you’re a reimbursing employer.
If your organization decides to change your status from a SUI taxpayer to a reimbursing employer, you will need to contact your state unemployment department. Each state is different, but there are often specific deadlines for when your status can be changed. Your organization should not rush into a decision, but with careful consideration you can find the best option for managing your nonprofit’s unemployment burden.